Newsom vetoed the California Crypto Bill – inviting even worse federal intervention

California Governor Gavin Newsom’s surprise veto of a bill to regulate cryptocurrency looks like a boon for consumers and creators alike. Unfortunately, his rationale for rejecting it is antithetical to promoting currency competition: Newsom is rolling out the welcome mat for even more expansive federal regulation, and anyone with a stake in the crypto market should be wary.

AB 2269, sponsored by some of Newsom’s fellow Democrats, surged through the California Assembly with unanimous approval. When the governor blocked it in late September, he did explained that he felt the bill was “premature” — not because it would compromise the potential of the industry it targets, but because it could forestall looming federal regulation.

As written, the bill will already deal a fatal blow to the crypto market in California and send devastating shock waves throughout the crypto space. Akin to New York’s famous BitLicense law, it would, as the policy group Blockchain Association notes, “actually outlaw” crypto businesses in California in two ways.

First, the bill would have forced all crypto exchanges – platforms where cryptocurrency tokens can be bought, sold, exchanged, sent or received – to apply for and obtain state-issued licenses to operate in California. It would suffocate small exchanges and startups that are unable to navigate a costly and cumbersome waiting game. It would also throttle consumer access to the newest platforms and apps, which are usually the first to carry the newest tokens. These volatile assets are often picked up by mainstream exchanges like CoinBase only after they have already skyrocketed in value from their launch price.

Cutting off smaller platforms’ ability to reach California’s 40 million residents—and blocking those residents from what is often the most lucrative trading stage—also cuts off creators’ and current merchants’ access to 40 million residents’ worth of potential buy-in.

Second, the bill would have shut out all businesses not licensed by the California Department of Financial Protection and Innovation (DFPI) – essentially all non-banks – from doing business with stable coins.

Among their many purposes, stablecoins can act as a kind of intermediary where exchanges and developers convert tokens and transfer information. Their value is tied to stable currencies, such as the US dollar, making them as stable as their “sticks”. For example, if a crypto company has US dollar assets on reserve, these tend to come in the form of stablecoin USDC, the digital US dollar token. Because they don’t require a credit card or a place to store physical currency, stablecoins are more accessible—and in many parts of the world, more secure– than their “pegs”. For that reason, they have become a critical means by which non-traditional financial entities expand access to communities that are underserved by brick-and-mortar banks.

By banning all non-bank stablecoin issuers from trafficking in the state of California, the bill effectively prohibits non-bank businesses from conducting crypto transactions with California consumers. It would also deal a blow to Californians privacy: Under AB 2269’s provisions, entities that can afford the cost and confusion of obtaining and maintaining a DFPI license will be required to keep records of all California client activity for five years.

Newsom justified his veto in a letter to supporters of the bill, paying lip service to calls for looser regulation: “A more flexible approach is needed to ensure that regulatory oversight can keep pace with rapidly evolving technology and use cases,” wrote. In a rare nod to budgetary restraint, the typical profligate the governor added that the bill would require a hefty loan from the state’s general fund for the first few years of implementation.

So far so good. But Newsom also declared it “premature to lock a licensing structure into statute without considering … upcoming federal actions” and pledged to work with state policymakers “to achieve appropriate regulatory clarity as federal regulations come into sharper focus.” In other words, this apparent patience may signal tougher federal legislation.

A patchwork of government regulations would stifle the creative spiral that characterizes the crypto market. But with regulation backed by the full force of the federal government, the damage could be fatal. Behind the jargon and platitudes, Newsom says his veto is a stopgap. He’s not trying to protect crypto from overbearing controls; he is about to clear the way for even stricter controls along the line.

Any new rules for the crypto market should protect entrepreneurs and investors from overzealous oversight, not expose them to it. And Californians should be wary of anyone who rejects a regulation because it’s not bureaucratic enough.